12/18/2002 @ 6:00PM

Major IPO Sends A Morose Message

Last week’s public offering of disk-drive maker
Seagate Technology
was ominous. The least of it is that, with tech stocks still shaky, investors were hot enough to pony up $870 million for reconstituted meat from the bottom of the food chain.

Seagate Technology
More worrisome is that the main sellers of the Seagate
shares are very smart money, who went ahead even though the offering price had to be cut 14% below the planned range. That says, “This is as good as PC hardware gets for as far out as we care to look.”

The “we” are seasoned dealmakers led by
Silver Lake Partners
. Most visible of Silver Lake’s superstar honchos is
Roger
McNamee
Roger McNamee
, whose enduring fame as a tech stock maestro began when he piloted the T. Rowe Price Science & Technology Fund to a 100% gain between 1988 and 1991.

At first glance, last week’s second coming of Seagate returned to the buyout investors $557 million of their original $875 million capital contribution. But last spring, Seagate had returned $200 million to them; and just prior to the IPO, another $262 million. That second payment nearly equals the $271 million of the IPO take earmarked for Seagate corporate purposes.

Combined with an additional $56.5 million of consulting fees, the buyout group has recouped its entire investment plus a two-year cash return of 26%, and still owns 80% of Seagate worth $4 billion. Silver Lake Partners owns about one-third of that booty.

IPOs are supposed to raise cash mainly to pursue a business. Seagate’s IPO has benefited only the buyout investors. The implicit rationale is that they had already done the work that normally would follow an IPO. Certainly Seagate’s value was enhanced by two years of restructuring. But the apparent compulsion of Silver Lake Partners to reap the rewards risk free and at great cost to Seagate doesn’t say much for their vision of the upside.

Like most investors these days, Silver Lake has reason to be gun-shy. Figures culled from U.S. Securities and Exchange Commission (SEC) filings of companies involved with its four other major investments–all announced in 2000–indicate a return to date of about $155 million on $615 million invested, or around 25%.

That’s far better than the fortunes of hundreds of venture capital funds that shoveled cash into dot-coms while Silver Lake engineered more mundane deals. But it barely equals the total return of bond market averages over the same period. Though that performance estimate involves guesswork about gaps in the public data, the experience of Silver Lake’s other investments clearly shaped the cash-back approach with Seagate.

Highly favorable terms for the original deals were significantly offset by subsequent declines of the stocks. For example, last summer Silver Lake’s stakes in online broker
Datek
and electronic trading system
Island ECN
were traded for $288 million of stock in
Ameritrade
and
Reuters
‘
Instinet
. The continuing market downturn in those stocks slashed the return on Silver Lake’s estimated $180 million combined investment to 22% from 60%.

More problematic have been
Enterasys Networks
and
Riverstone Networks
, the main products of a 2001 spinoff reorganization of
Cabletron
, which was eating
Cisco Systems
‘
dust. Much of Silver Lake’s upside vigorish on its $134 million cash outlay is in warrants exercisable at prices more than three times above the current stock prices.

Worse, 60% of the $155 million total gain estimated for Silver Lake’s major holdings apart from Seagate is in rights to redeem Enterasys preferred stock for cash this coming February. But doing that would cripple the company. Silver Lake will instead be forced to renegotiate the terms of the preferred, upping its stake rather than cashing out of it. Last week Enterasys was hit by escalating class-action charges related to last February’s announcement of an SEC investigation and restatement of 19 months of financials.

More successful has been the April 2000, $300 million investment in technology research consultant
Gartner
, made via 6% convertible notes that pay interest by increasing their face value. Though Gartner shares are down 40% from the deal price, Silver Lake’s effective return is 45%. That’s thanks to terms that slashed in half the conversion price when Gartner stock tanked to all-time lows in April 2001.

More than compensating for the mixed returns of those four investments is Silver Lake’s home-free, $1.3 billion stake in Seagate. That rockets the estimated three-year return of the combined deals to 144%–a stunning score versus the 70% decline of tech stock averages over the same period. Still, Silver Lake’s reset of its Seagate bet to ride only on other investors’ money is a megabuck statement that clear blue skies aren’t yet on the horizon.